Money Supply and Stability
SEPTEMBER 01, 1981 by LUDWIG VON MISES
The fateful errors of popular monetary doctrines which have led astray the monetary policies of almost all governments would hardly have come into existence if many economists had not themselves committed blunders in dealing with monetary issues and did not stubbornly cling to them.
There is first of all the spurious idea of the supposed neutrality of money. An outgrowth of this doctrine was the notion of the “level” of prices that rises or falls proportionately with the increase or decrease in the quantity of money in circulation. It was not realized that changes in the quantity of money can never affect the prices of all goods and services at the same time and to the same extent. Nor was it realized that changes in the purchasing power of the monetary unit are necessarily linked with changes in the mutual relations between those buying and selling.
The assumption that the medium of exchange is a neutral factor was a serious blunder. People tacitly assumed that changes in purchasing power occur with regard to all goods and services at the same time and to the same extent. This is, of course, the fable of money’s neutrality.
The notion of a neutral money is no less contradictory than that of a money of stable purchasing power. Money without a driving force of its own would not, as people assume, be a perfect money; it would not be money at all.
The purchasing power of money is determined by demand and supply, as is the case with the prices of all vendible goods and services. The demand for a medium of exchange is the composite of two partial demands: the demand displayed by the intention to use it in consumption and production and that displayed by the intention to use it as a medium of exchange. The value in exchange (purchasing power) of a medium of exchange is the resultant of the cumulative effect of both partial demands.
Money is not a standard for the measurement of prices; it is a medium whose exchange ratio varies in the same way, although as a rule not with the same speed and to the same extent, in which the mutual exchange ratios of the vendible commodities and services vary.
With action and unceasing change, with the economic system which cannot be rigid, neither neutrality of money nor stability of its purchasing power are compatible.
All plans to render money neutral and stable are contradictory. Money is an element of action and consequently of change. Changes in the money relation, i.e., in the relation of the demand for and the supply of money, affect the exchange ratio between money on the one hand the vendible commodities on the other hand. These changes do not affect at the same time and to the same ex tent the prices of the various commodities and services. They consequently affect the wealth of various members of society in a different way.
Changes in the supply of money must bring about changes in other data too. The market system before and after the inflow or outflow of a quantity of money is not merely changed in that cash holdings of the individuals and prices have increased or decreased. There have been effected also changes in the reciprocal exchange ratios between the various commodities and services.
It is generally believed by those unfamiliar with economic theory that credit expansion and an increase in the quantity of money in circulation are efficacious means for lowering the rate of interest permanently below the height it would attain on a nonmanipulated capital and loan market. This theory is utterly illusory. But it guides the monetary and credit policy of almost every contemporary government.
The endeavors to expand the quantity of money in circulation either in order to increase the government’s capacity to spend or in order to bring about a temporary lowering of the rate of interest disintegrate all currency matters and derange economic calculation.
It is not on account of an alleged scarcity of money that prices of agricultural products are too low to secure to submarginal farmers the amount they would like to earn. The cause of these farmers’ distress is that other farmers are producing at lower costs.
An increase in the quantity of goods produced, other things being unchanged, must bring about an improvement in peoples’ conditions. Its consequence is a fall in the money prices of the goods the production of which has been increased. But such a fall in money prices does not in the least impair the benefits derived from the additional wealth produced. One must not say that a fall in prices caused by an increase in production of goods is proof of some disequilibrium which cannot be eliminated otherwise than by increasing the quantity of money.
The services which money renders can be neither improved nor repaired by changing the supply of money. There may appear an excess or a deficiency of money in an individual’s cash holding. But such a condition can be remedied by increasing or decreasing consumption or investment. (Of course, one must not fall prey to the popular confusion between the demand for money for cash holding and the appetite for more wealth.) The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.